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In search of golden dividends

Nathan Bell

Since reaching lows of less than $US300 an ounce 12 years ago, the price of gold has rocketed.

Last year, the yellow metal peaked at over $US1900 an ounce. Despite recent falls, it still trades around $US1600 an ounce today.

One might imagine that a soaring gold price would propel the shares of gold miners higher. And yet gold equities have performed miserably over the course of the gold boom.

Since 2003, S&P’s Global Gold Index Fund (XGD), a measure of the performance of global gold-miners, has risen just 42 per cent. Meanwhile, the most popular pure gold exchange traded fund – listed on the New York Stock Exchange as GLD – has increased almost 250 per cent over the same period.

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The explanation is simple enough: investors have cottoned on to the fact that gold mining is an awful business.

As the gold price has increased, instead of passively collecting higher margins, gold producers have chased increasingly marginal production. A higher gold price has allowed them to consider mining ore that wasn’t previously profitable, and to spend a truckload more money getting it out.

What looks like a business able to deliver higher margins from a rising gold price ends up being one that constantly spends more to make less; costs escalate as production increases, political risks are ever-present, as are geological constraints.

These are the reasons for poor industry performance.

Investors have had it with gold stocks. They’ve chosen ETF (exchange-traded fund) exposure instead. In terms of market capitalisation, the GLD ETF is now more than 2.5 times larger than Barrick Gold, the biggest goldminer on the planet.

The industry is now waking up to the fact that it has wasted an opportunity to profit from a decade-long boom in the gold price.

They’re finally ditching the idea of marginal production growth in favour of focusing on returns. To compete with ETFs, companies like Evolution Mining and Endeavour Mining have even suggested linking their dividends to production or paying them in gold rather than cash.

If you buy the argument that gold is a currency rather than a commodity and that investors want exposure to gold to escape the dominance of fiat currency, paying dividends in gold rather than in the currency investors are fleeing makes sense.

Gold is the oldest enduring form of money, a currency not a commodity. And it’s rare. All the gold ever mined would fit into two and a half Olympic-sized swimming pools. And, unlike paper money, which central banks can create without limit, gold supply increases on average by only 2 per cent per annum.

Gold investors have three basic options: buy gold bullion; buy financial products linked to gold; or buy gold mining stocks. In recent years, that last option has been forgotten in favour of the first two. Now the tide may be about to turn.

Equity values have lagged gold prices for miners big and small. At some stage, the market’s snub of gold equities will surely reverse. With these changes in the industry, perhaps that time isn’t so far away.

This article contains general investment advice only (under AFSL 282288).